Steve Kim – Avoid emotional pitfalls to maximize your investments

Steve Kim

Steve Kim COURTESY PHOTO

By STEVE KIM

For the Ledger-Transcript

Published: 06-18-2024 11:01 AM

Let us get the elephant out of the room – money is emotional.

How can it not be, when it provides for your children’s education, memorable vacations and so much more? It is only natural to worry when the stock market takes a dive, and you see the value of your hard-earned money shrinking.

But during those times, it is crucial to balance emotion with logic, because those who sell out of fear almost always miss out on the upswing to come. The trick is not letting emotion derail your investments, but rather inform them.

It can be difficult to identify emotional decision-making. In a classic example, an investor buys as stock values rise, driven by confidence that prices will continue to increase. But when this trend inevitably reverses, fear kicks in and grows as the price continues to fall. This investor, driven by fear of greater and greater loss, sells out of perceived desperation. Their habits lead them to buy high and sell low, trapping them in a cycle of money loss and regret.

Counteracting this confidence-fear cycle with logic is helpful. In short time periods, the stock market displays volatile behavior, but since 1930 has exhibited consistent long-term growth. Keeping a long-term focus can help to cope with short-term losses. The investor simply needs to wait out the low periods and let time improve the market. However, long-term growth can only benefit the investor if they refrain from selling.

There are other, more-subtle ways emotion creeps into a logical strategy. People are influenced by herd mentality. In other words, if a successful friend invested in certain companies, it is easy to think, “I’ll do the same thing, and be successful, too.”

What is impossible to see is that friend’s comprehensive financial strategy and personal risk tolerance. What works for one person may not be a smart decision for another. Financial advisers’ role is to select the ideal strategy for you. When you feel secure in your strategy, it is often easier to tune out the “noise” of what everyone else is doing.

People sometimes avoid making portfolio changes due to fear of making the wrong decision. It can feel safer to stick with the status quo, even though reallocating would increase chances of long-term growth. Scared of missing out on future gains, these investors hold on to a stock that they would be better served to sell. Just as the person in the first example sold too quickly for fear of increasing losses, this investor refrains from selling in the hope of future gain.

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Though anxiety impacts each in opposite ways, the end result is the same –  portfolio underperformance due to fear.

With introspection, we can become aware of when fear or greed is guiding our actions. Speaking with an adviser you trust can also help you identify emotional factors. But if we should avoid the aforementioned approaches, then what should we focus on?

The first step is identifying your goals. Whether you want to save for retirement, help your children buy their first house or supplement your income, emotion inform your goals. But once you discern the desired end result, it is time for emotions to take a back seat. Allocating your investments logically to accomplish your goals is the challenge, and a financial adviser’s area of expertise.

In general, your goals and risk tolerance are intertwined. For example, if you need cash for a down payment on a house within the next three years, investing that money in stocks would pose too much of a risk for your intended purpose. 

As mentioned, stock returns can be volatile for shorter time periods but usually have a higher yield in the long term. The S&P 500’s average annual return over longer time periods – typically 10 years – is about 9%. Bonds, on the other hand, historically have an average yearly return of around 5%, and display more-predictable behavior in the short term.

Most broadly, stocks are ideal for investment periods greater than 10 years, bonds for less than five years and cash for two years or less. But the exact ratios of stocks to bonds to cash depends on your specific goals and risk tolerance.

Regardless of your investments within each broad category, diversification is key, so if one company underperforms, your shares in an excelling company give balance. Time and time again, financial advisers prove indispensable for maximizing your portfolio to your specific situation, and in helping regulate emotional decision-making.

Steve Kim offers securities and investment advisory services through Gradient Securities, LLC. Member FINRA/SIPC. Gradient Securities, LLC offers investment advisory services under the d.b.a. of Gradient Wealth Management. Gradient Securities, LLC, and its advisers do not render tax, legal, or accounting advice. Brady Associates Asset Management is not affiliated with Gradient Securities, LLC.